The Present Doesn’t Portend the Future

You probably know the well worn disclaimer in the investing world, “past performance is no guarantee of future results.” It’s essentially how many investment firms wow you with statistics about their past performance, only to remind you that your future results may never match theirs. OK, fair enough, so how about present circumstances? Do they portend the future?

It’s human nature to focus more on the present than the future, which is in line with our basic instinct of survival. After all, if we don’t take care of the here and now, there may not be a future, right?

Marketing departments know this! Many things in life are about experiencing pleasure today, and pushing the cost of that pleasure into the future (credit cards anyone?). Drive off with the car with zero dollars down, and pay over 84 months. Go ahead–have another piece of cake – you can work it off later. No problem.

Many decisions investors face, have similar tradeoffs. Buy a new car or put more money into retirement? Take another vacation or fund the college account? And the further out the consequence, the less weight we tend to give to it. This is because we have a hard time imagining the future…especially way into the future.

Smart Today May Not Be Smart Tomorrow

We tend to extrapolate the present into the future, as if things will never change and will continue the status quo.

In the financial crisis of 2008-2009, many people were selling after experiencing financial losses. Some of that selling came just weeks before the market hit bottom. What would cause an investor, who desires to buy low and sell high, to sell after experiencing significant (yet unrealized) losses (i.e. sell low)? One factor is that they were extrapolating the present into the future…they couldn’t see how things would change.

Another great example is the German Bund (treasury bond). In 2016, Germany sold the 10-year Bund at a negative yield (this means that buyers were guaranteed to get back less principal than they originally put in). Those investors were certain that rates would continue going negative for the next 10 years. But here we are almost two years later and the current yield is already over +0.50%. Substantial money (principal) may be lost on this bond simply because investors extrapolated the “present of 2016” into the future.

More recently, the stock markets have struggled to continue the torrid advance that began with the presidential election in 2016, lasting through this past January. The markets had a handful of “1% days” during a low volatility year in 2017, yet so far in 2018, we’ve had more 1% days than all of 2017 as volatility has returned. While the markets haven’t yet closed more than 10% from their January peak, you’ve probably read or heard the prognosticators calling this correction the beginning of the end for the bull market. Enough investors will be scared witless of enduring another 2008-2009 selloff that they’ll sell now and probably miss the next great advance that makes another new all-time high sooner than they can presently imagine.

History May Help Here

Think about everything that has happened in the last 10 years–of course, a lot has happened. And while we may not be able to project what will happen in the future, how it will happen or when, we know – through the history of mankind – that lots of unexpected things will occur. Another crisis is always bound to come along.

The plans that we have developed for our clients prepare them for many different scenarios. They take into account their risk tolerance, time-frame and overall monetary goals and dreams.  But we don’t have to get any one scenario right. We just need to be disciplined enough to stick with the plan through both the good and the tough times.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Source: Information obtained from The Emotional Investor

Trade War, What is it Good For?

“War, what is it good for? Absolutely nothing!” – from the 1969 song “War” by Edwin Starr

When most of us hear talk about something described as a “war,” we intuitively recognize that there could be very unpleasant outcomes on all sides. Wars have one thing in common: there is seldom a clear-cut “winner” amid the damage and destruction.

So when President Trump declares a “trade war” against the world’s second-largest economy, it’s natural that many people—including, apparently, a large number of investors—would feel spooked about what’s to come in our collective future. This explains why every escalation of words, and new lists of things that will be taxed at U.S. and Chinese borders, has provoked sharp downturns in the markets.

But what, exactly, is a “trade war?” Beyond that, what is a “trade deficit” and why are we trying to “cure” America’s trade deficit with China?

To take the latter issue first, every bilateral trade deficit is simply a calculation, made monthly by government economists, that adds up the value of products manufactured in, say, China, that are purchased in, say, the U.S. (Chinese exports or U.S. imports), and subtracts the value of products manufactured in the U.S. that are purchased by Chinese consumers (U.S. exports or Chinese imports). The first thing to understand is that this is not a very precise figure. To take a simple example, Apple manufactures its iPhones in southern China, ships them to the U.S. for sale, and the value of each of the millions of smart phones is counted as a Chinese export to the U.S. market. Apple reaps extraordinary profits, but this is considered a net negative in terms of U.S. trade.

Moreover, the full value of each iPhone is considered on the import ledger, without subtracting out the value of the “services” that Apple provides. The software and design were, after all, created in the U.S., and are a large part of the value of the phones that people become so addicted to. But these financially valuable aspects of the phone, made in America, are not reflected in the trade numbers.

Beyond that, many economists question whether a trade deficit is a bad thing in the first place. Chances are, you run a significant trade deficit with your local grocery store; that is, it brings to your neighborhood the food you put on the table, and you exchange money for it. You import food, but the grocery store doesn’t import a comparable amount of things you make in your garage. Are you materially harmed by this economic opportunity that takes dollars out of your pocket and puts them in the hands of the grocery store? If you were, you might take your business to the grocery store further up the road, and run a trade deficit with a different establishment.

How does this relate to the U.S./China trade relations? Simple mathematics indicate that Chinese manufacturers are taking dollars from U.S. consumers, but they have to do something with those dollars to balance the ledger. That money finds its way into purchases of U.S. debt (Treasury bonds) or reinvestment in the U.S. economy, buying real estate or investing in domestic companies.

You fight trade wars with tariffs, which are simply a government tax on specific items when they cross the border. So when the Trump Administration announces the list of 1,300 different products that will become the targets of its tariff plan, that means that anyone buying those products will see their taxes go up—invisibly, in a higher cost of living.

The bigger potential damage comes when China retaliates in kind, and certain sectors of the U.S. economy have to pay the Chinese government a tariff for the privilege of selling their products to the Chinese market. China represents 15-20 percent of Boeing’s commercial airline sales, so a proposed 25% tariff could sting. More directly impacted are U.S. farmers. Soybeans represent the largest agricultural export from the U.S. to China ($14.2 billion worth of shipments in 2016, about one-third of the U.S. crop), and the Chinese consume a lot of U.S.-raised pork. When the tariffs were announced, pork futures dropped to a 16-month low, and soybean futures fell 5% overnight.

The larger concern is that China is preparing to shift its sourcing of agricultural products from the U.S. to Brazil and Argentina, and the retaliatory tariff makes this economically attractive for Chinese consumers. Will that business ever come back again?

If this has you worried, or searching China’s latest list to see which stock might be impacted as the rhetorical trade war escalates, it might be helpful to take a step back. So far, none of these tariffs have been levied; no actual shots have been fired in the trade war, which means it is not yet a “war” at all. The U.S. and China are trading retaliatory lists of potential targets, and there is some escalation in the value and extent of those lists. But when it comes time to actually fire those shots, the most likely scenario is a generous compromise that leaves us with the status quo.

Remember how worried the markets were when the Trump Administration abruptly announced new levies against global steel and aluminum imports? It turned out to be mostly bluster. A full 50% of all U.S. steel imports, from Brazil, South Korea, Mexico, Canada and others, were exempted from those tariffs. Larry Kudlow, the White House’s new economic advisor, said several times last week that there would be, in fact, no new tariffs, and no trade war with China. It will be months before any of the proposed tariffs could be put into place, which is plenty of time for Kudlow’s prediction to come true—and make all the panic sellers who drove down stock prices look a little bit silly.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

https://www.politico.com/magazine/story/2018/04/07/how-to-win-trade-war-china-217830

http://www.slate.com/articles/business/the_edgy_optimist/2014/03/u_s_china_trade_deficit_it_s_not_what_you_think_it_is.html

https://www.forbes.com/sites/timworstall/2016/12/16/apples-service-exports-mystery-and-why-the-trade-deficit-simply-does-not-matter/#247c14b13934

https://www.desmoinesregister.com/story/money/business/2018/04/06/futures-file-trade-war-looms-soybean-prices-unscathed-now/493685002/

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

 

 

 

Is the Bull Market Finally Over?

After more than a year of historically low volatility, January markets came in like a lamb and went out as a lion, and the lion has stuck around so far. It’s safe to say that volatility is here to stay for awhile, prompting most people to ask:

Is the bull market finally over?

For the first time in nine calendar quarters, the U.S. investment markets delivered a negative overall return. It was only a slight decline, but the decline reminds us that markets can and do go down from time to time.

After starting the year strong, the Wilshire 5000 Total Market Index—the broadest measure of U.S. stocks—finished the quarter down 0.76%. The comparable Russell 3000 index was down 0.64% for the first three months of the year.

Large cap stocks posted identical small losses. The Wilshire U.S. Large Cap index dropped 0.76% in value, while the Russell 1000 large-cap index fell 0.69%. The widely-quoted S&P 500 index of large company stocks dropped 1.22% in value during the year’s first quarter. Meanwhile, the Russell Midcap Index fell 0.46% in the first three months of the year.

As measured by the Wilshire U.S. Small-Cap index, investors in smaller companies posted a 0.73% loss over the first three months of the year. The comparable Russell 2000 Small-Cap Index lost a bit of ground as well, falling 0.08% for the quarter. The technology-heavy Nasdaq Composite Index finished the quarter with a gain of 2.33%, making technology the standout performer of the year so far.

International stocks are fully participating in the downturn. The broad-based MSCI EAFE index of companies in developed foreign economies lost 2.37% in the recent quarter. In aggregate, European stocks were down 2.57% over the last three months, while MSCI’s EAFE’s Far East Index lost 0.67%. Emerging market stocks of less developed countries, as represented by the MSCI EAFE EM index, gained a meager 0.93% in dollar terms in the first quarter.

Looking over the other investment categories, real estate, as measured by the Wilshire U.S. REIT index, fell 7.42% during the year’s first quarter. The S&P GSCI index, which measures commodities returns, gained 2.37% in the first quarter.

In the bond markets, coupon rates on 10-year Treasury bonds have continued a slow but steady rise to 2.75%, while 30-year government bond yields have fallen slightly to 2.97%. Five-year municipal bonds are yielding, on average, 2.06% a year, while 30-year munis are yielding 3.01% on average.

What’s going on? The first quarter saw the first correction—that is, a decline of more than 10%–in three years, which dragged returns down from a roaring start to the year. Industry pundits have many triggering effects to point to, from chaos in the White House to the possibility of a global trade war, to fears of inflation or higher interest rates, to the simple fact that U.S. stocks have been priced much higher than their historical averages. They aren’t getting much explanatory data from the economic statistics; the unemployment rate is testing record lows and new jobs are being created at record levels. More importantly, annual earnings estimates for S&P 500 companies rose 7.1% during the first three months of the year—the fastest rise since FactSet began keeping track in 1996.

Ironically, the small downturn plus the jump in earnings may have forestalled a bigger corrective bear market later. The S&P 500, by some measures, is now trading at 16.1 times projected earnings for the next year, compared with 18.6 in late January when the markets were extraordinarily bullish. Stocks are not as overpriced as they once were, and the corporate tax cut could lead to higher reported earnings throughout the year.

Some are questioning whether the large cap indices fully reflect the overall U.S. economy these days. As mentioned earlier, the technology sector is generating positive returns. If you were to take Amazon.com, Microsoft, NetFlix, NVIDIA Corp., Cisco Systems and Apple, Inc. out of the S&P 500, the downturn would have been much worse, as companies like Procter & Gamble, Exxon Mobil and General Electric all lost value. As tech roars and more traditional companies see their shares losing value, technology makes up a greater portion of the capitalization-weighted indices, and its returns will have a higher impact in the future.

In any case, it appears that investors have become increasingly nervous about their stock investments. Over the past three months, the CBOE Volatility Index–the VIX index–widely known as Wall Street’s “fear gauge,” posted its biggest quarterly rise since the third quarter of 2011, jumping 81%. The VIX reflects option traders’ collective expectations for the S&P 500 index’s volatility over the coming 30-day period, and by this measure, traders had been very calm for the 18 months before early February. Now the VIX is at or near its historical average, which suggests that the equities markets are going to experience a totally normal bumpy ride going forward. This is a good time to fasten seat belts, and also consider whether you’d have the patience to ride out a bear market. We can’t predict when that will happen, of course, but I think everybody realizes that the bull market cannot last forever.

At this stage of the bull market, the strength in the economy (overheating?) and lack of major technical divergences prompt us to continue giving this bull the benefit of doubt. Yet, with a bull market long in the tooth, over-confident consumers, an unfavorable monetary climate, and some frothy optimism, the level of market risk today is high and rising. While a new bull market high may still lie ahead, now may be time to take incremental steps to prepare for the next major downturn, and that’s precisely what we’ve been doing in client portfolios this year. We’ve reduced market exposure and have increased our hedges as previously communicated. Further changes will depend on the evidence as it unfolds.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

Wilshire index data: http://www.wilshire.com/Indexes/calculator/

Russell index data: http://www.ftse.com/products/indices/russell-us

S&P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf–p-us-l–

Nasdaq index data:

http://quotes.morningstar.com/indexquote/quote.html?t=COMP

http://www.nasdaq.com/markets/indices/nasdaq-total-returns.aspx

International indices: https://www.msci.com/end-of-day-data-search

Commodities index data: http://us.spindices.com/index-family/commodities/sp-gsci

Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/

Bond rates:

http://www.bloomberg.com/markets/rates-bonds/corporate-bonds/

General:

http://money.cnn.com/2018/04/01/investing/stocks-week-ahead-valuation/index.html

https://www.marketwatch.com/story/tech-is-responsible-for-nearly-all-of-the-markets-2018-advancedespite-facebooks-stock-woes-2018-03-22

https://www.marketwatch.com/story/the-simple-reason-the-dow-is-ending-a-9-quarter-win-streak-wall-streets-surging-fear-index-2018-03-29?link=MW_popular

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

What’s Going on in the Markets April 7, 2018

Notes: I’m sharing a letter that we sent out on Saturday April 7, 2017 to our clients, prospects and friends to let them know how we’re handling this market correction.

Sandwiched between two “down” days in the markets this week (Monday and Friday), were three “up” days, culminating in an overall 1.4% weekly loss in the S&P 500 index. Fears of a full-blown trade war receded on Tuesday, resulting in a mid-week rally that eventually faded on Friday, as trade war fears resurfaced and weighed on the markets.

Despite the threats of a trade war, the outlook for the economy and corporate earnings, the fundamentals that truly drive the markets over the long term, both remain quite positive. Both surveys from the Institute for Supply Management (manufacturing and services) are firmly anchored in growth territory. And although yesterday’s monthly payroll report revealed that there were fewer jobs created in March (probably weather related), the unemployment rate remained unchanged at 4.1%.

The broad market indexes are fluctuating near their recent lows as the market correction (and volatility) continues to unfold. The typical market correction lasts roughly 12 to 16 weeks, and this one is about 11 weeks old. But there are signs that the market is in a final bottoming process that could potentially yield a multi-week or multi-month rally which could start any day now. Corrections never feel good while they’re happening, but they’re a healthy way of “digesting” past gains and to keep the markets from overheating after a prolonged period of going up. January was particularly strong this year, but all those gains and more have been surrendered during this correction.

During this correction, clients may have noticed increased trading activities in their accounts. Our standard practice at the start of and during a correction are to:

  • Raise cash levels by selling some profitable or underperforming positions.
  • Increase hedges (a hedge is risk reducing instrument) through the use of inverse funds (funds that go up when the market goes down) and options.
  • Adjust (short) options that were sold to take advantage of higher premiums and volatility, which results in additional portfolio income as we roll out to later months. Short options also act as hedges on the portfolio.
  • Use technical signals in the market to identify potential bottoms, to begin putting available cash to work in new (now lower cost) positions.
  • When uncertainty and risk are high, but opportunities present themselves, we may decide to limit client risk through the purchase of call options, or by selling put options, instead of purchasing outright shares. Both approaches increase exposure to the market with less risk than outright share purchases.
  • Identify spots where it is deemed prudent to remove or trim hedges to reduce their overall “drag” on the portfolio. Hedges that are removed may be re-instated if the markets unexpectedly turn back down, sometimes even a day or two later.
  • Monitor new positions purchased during the early stages of market recovery to ensure that these positions are “working”, keeping them on a short leash. All such positions are considered short-term until the market ultimately proves itself. Some positions that turn profitable but return to their buy point are sold for a small profit or small loss.

As the market showed signs of making a bottom early in the week, we were particularly active in reducing hedges and testing new positions. Because of Friday’s decline, unfortunately, we found ourselves reinstating some of those hedges and selling some of the newly established positions for a small profit.

Back to square one.

The process of market bottoming is an inexact science, much like the process of investing, so fits and starts are to be expected. As Friday’s decline gave back all the week’s gains and then some, we begin the process of looking for another market bottom next week.

During a correction (or outright bear market) our objectives remain to protect client capital first, and grow it second. Until safer market conditions present themselves, and volatility subsides, we will remain defensive and have a bit of an “itchy trigger finger” with new and existing positions.  We trust and hope that you agree with this approach, even if it increases the number of trades we make. Please excuse the extra trade confirmations that hit your in-box.

Next week kicks off the start of quarterly corporate earnings reporting season, wherein companies report their financial results for the first quarter of 2018. Estimates are that companies expect to report earnings that are on average 17% higher than the first quarter of 2017. If those results pan out as expected or better, we may be looking at this correction in the rear view mirror in a few weeks.

The dichotomy between a solid economy and a nervous, volatile market is a dilemma that requires patient discipline and an understanding of market history. It is still too early to determine if this is just a lengthy correction or if it could lead to a further decline and a full-blown bear market. Given the elevated risk and persistent volatility, however, it’s important to remain defensively positioned and to objectively evaluate key indicators as the evidence continues to unfold.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

 

 

Source: InvesTech Research

 

What’s Going on in the Markets March 25, 2018

With the threat of a trade war, the appointment of a new National Security Advisor, and potential war drums being pounded, the markets took a pounding of their own last week. After a robust recovery, the stock markets now seem intent on re-testing the February 8th lows.

As stocks went on sale again, there didn’t seem to be a lot of bargain hunters stepping in to take advantage of the lower prices. The S&P 500 lost 5.9% over five days, its worst week since January 2016.

S&P 500 weekly change

This action follows a by-now-familiar pattern: the Trump Administration announces tariffs—this time on Chinese imports with an estimated value of $60 billion a year—but is not specific on the details. Traders fear that there will be retaliation against American products sold abroad, and put a lower value on the large multinational companies that account for most exports and make up most of the major indexes.

The last time this happened, the tariffs involved steel and aluminum, and the panicked sellers later discovered that the impact on global trade was actually quite small, due to negotiated exemptions for major steel producing nations like Canada and South Korea—plus the Euro-zone and Mexico. This time around, the U.S. trade representative has 15 days to develop a list of specific Chinese products to slap the additional taxes onto, and there will be a public comment period before the threatened tariffs go into effect. China has announced that it is developing its own list, and as companies (and farmers) become aware of what is included in its reported $3 billion tariff package, they will lobby for exemptions which may turn this announcement into another tempest in a teapot.

Meanwhile, in the wake of the Cambridge Analytica scandal, admissions that private information on 50 million people had been pilfered, and up to 126 million Americans had seen posts by a Russian troll farm on its site, Facebook shares fell almost 10%, from $176.83 down to $159.39. This took the social media giant down from the 5th largest-capitalization company in the S&P 500 index to the 6th (behind Berkshire Hathaway)—dragging the index down even further.

What’s remarkable about the selloff over things that might or might not happen, is that it came amid some very good news about the U.S. economy. Durable-goods orders jumped 3.1% in February, sales of newly-constructed homes were solid, and Atlanta Fed president Raphael Bostic announced that there were “upside risks” in GDP and employment. Translated, that means that the economy is looking too good to keep interest rates as low as they have been—which means this is a curious time to be selling out and heading for the investment sidelines.

Of course, that doesn’t mean that the market can’t “correct” further. As the market tests the February 8 lows, an overshoot to a new low cannot be ruled out, but all the selling last week is at least arguing for a robust bounce, which I expect to materialize this week. The quality and durability of that bounce will tell us a lot about the strength of the market going forward.

The week before the Easter holiday tends to be seasonally bullish, as long as cooler heads prevail.  If you haven’t lightened up your portfolio risk in a very long time, and feel the need to reduce your stock fund exposure, that may be a better time to lighten up your risk. Heck, if you’re under-exposed to stocks, this may be a good place to pick up some of your favorite names at a discount.  Disclaimer: this is not a recommendation to buy or sell any securities.

For our clients, we have reduced exposure to some overvalued stocks and funds over the past several weeks, increased exposure to some undervalued ones, and have increased our hedges to reduce our overall risk. For the most part, however, the benefit of the doubt goes to this bull market until economic and market conditions change drastically.

Whatever you do, don’t panic as a result of the headlines. There’s always a better time to sell, and that’s not into the teeth of a headline driven sell-off. As I’ve said before, market volatility is the price we pay for the superior returns of stocks, and now that’s what we’re paying for. Stocks can only give you superior returns if you don’t panic out of them at the first sight of turbulence.

If you would like to review your current investment portfolio, your level of risk. or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:

http://theirrelevantinvestor.com/2018/03/23/8750/

https://www.marketwatch.com/story/heres-why-the-stock-market-took-the-china-tariffs-so-hard-2018-03-22

https://www.usatoday.com/story/money/2018/03/22/stock-market-falls/448665002/

http://www.symbolsurfing.com/largest-companies-by-market-capitalization

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

It’s My Turn to Retire-How do I Pay Myself?

It’s no surprise that more and more of my clients (and prospects) are coming to me as they approach retirement and are increasingly anxious about how to make the transition from accumulation of their retirement funds to distribution of those funds. Questions like “when should I claim social security, how much is safe to withdraw each year, what account should I take it from first, how will taxes affect my retirement, how should I safely invest during retirement, what should I budget for healthcare costs, what medicare plans are best for me?” are among the many questions on pre-retirees’ minds.

With an estimated 10,000 people retiring every day, this unprecedented surge of new retirees is expected to last for the next 17 years. Many, perhaps most, will roll their retirement plan assets into an IRA account, and that money–plus Social Security, possibly a small pension and any taxable retirement accounts they may have–will provide their living expenses for the rest of their lives.

This is different from retirees in the past, who often received regular sizeable payments from their defined benefit plans–their equivalent of a retirement paycheck. Millions of new retirees are being required to make a new kind of calculation: how do I translate a lump sum retirement account into sustainable income over the rest of my retirement? For those of us who are accustomed to receiving income throughout our lives, this is not an easy calculation to make.

Suppose, for example, a 65-year-old couple retires, and when their pension assets are rolled into the IRA, they have a total of $4 million between the IRA and their retirement accounts. They can start receiving $1,750 a month from Social Security. With so much money in the bank, they feel comfortable joining an expensive country club, traveling around the globe, and before long, a large recreational vehicle is parked in their driveway. They remodel the kitchen. By age 68, they still have $2.5 million in the bank and are back down to spending $170,000 a year (including taxes). Are they all right, or not?

This is the kind of calculation that financial planners who serve retiree couples wrestle with all day long, and there are few definitive answers. Some of the pioneering research into safe spending in retirement, most notably by Bill Bengen of La Quinta, CA, take into account what is called “sequence risk”–meaning that some unlucky retirees will experience a severe market drop in their early years, which will make it more likely that they’ll run out of money before they die. The research assumes that the retired couple wants to raise spending, each year, at exactly the inflation rate, so they maintain spending power and overall lifestyle. Then it looks at the historical market returns, and identifies a spending level that would have survived even the worst sequence risk scenarios. The answer is between 4% and 4.5% of the retirement portfolio in the first year, with that dollar amount rising with the inflation rate each year (that approach requires retirement savings of approximately 20-22 times your annual lifestyle budget expected in retirement) .

In our hypothetical retiree example, Social Security is paying for $21,000 of the couple’s living expenses, meaning the portfolio has to come up with an additional $149,000, indexed to inflation, for the next 30 or so years. That comes to almost exactly 6% of the remaining portfolio. The couple feels financially solvent, but they are really highly at risk if the market turns down in the next few years.

Other research, notably by Jon Guyton of Minneapolis, MN, has factored in the possibility that a retired couple will be willing to forego inflation increases in years when their retirement portfolio has lost money. This so-called “adaptive withdrawal” strategy allows a retiree couple to raise spending to approximately 4.8% of the initial portfolio. Once again, under this other scenario, our hypothetical couple is in the spending danger zone. And this only covers a 30-year period. People who live longer would need to live on somewhat less–but how do you know how long you’ll live?

Others, including Jim Shambo of Colorado Springs, have looked at the Bureau of Labor Statistics research on actual spending in retirement, and found data that questions the assumption that people in retirement only increase their yearly spending by the inflation rate. Shambo found that the government-calculated Consumer Price Index appears to understate actual yearly increases in retirement spending by as much as one and a half percentage points a year–meaning if the CPI goes up by 3%, actual spending may rise by anywhere from 3.25% to 4.5%. Using a more complex calculation, Shambo found that people age 75 and older were spending between 13.2% and 22.07% more than the inflation statistics would indicate.

Of course, all of this research focuses on surviving the worst-case scenario–the times when the markets are least favorable to a comfortable retirement. If the market climate is, instead, sunny during the early years of retirement, if our hypothetical couple happened to retire in the early years of a bull market, then their current spending won’t be a problem, and they may actually be able to increase their lifestyle expenditures.

Self-serving statement alert: The only way to stay in the safety zone is to have a professional run the numbers every year in light of recent market activity and long-term guidelines, and help you chart a course through the income maze. Converting a portfolio into a paycheck is a surprisingly complex exercise. Ten years down the road, when a few million baby boomers are well into retirement, you may be reading about some of the simple, innocent, tragic mistakes they made with their spending decisions when it felt as if they were flush with cash.

If you would like to review your retirement income options, current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Sources:  http://www.fpanet.org/journal/HowtoAchieveaHigherSafeWithdrawalRate/

http://www.advisorperspectives.com/newsletters12/The_Fallacies_in_Todays_Retirement_Plan_Assumptions.php

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

How Firm is your Investment Character?

One time Fidelity Magellan Fund manager and investing legend Peter Lynch once said “The real key to making money in stocks is not to get scared out of them.”

Benjamin Graham said “What investors need, but few have, is a “firmness of character.”” What he was referring to is the ability for investors to keep their emotions in check.

Investing success is more influenced by DQ than IQ. Our Discipline Quotient, or the ability to remain disciplined during emotional times, is what sets investors apart. Exercising investment discipline is a difficult, but not impossible endeavor.

Buy Low, Sell High

Every investor wants to buy low and sell high, yet it is so much easier to sell low and buy high; it just feels right at the time. Very few investors have the discipline to buy low or sell high because it is contrary to how we feel.

The price to earnings ratio (P/E) is a financial statement term that compares the price of a stock to the annual earnings per share (also called the earnings multiple).  Would you rather purchase a basket of stocks with an average P/E ratio of 13 or 34? Well, if you want to buy low, then 13 would be your answer. Yet, in March of 2009 with a market P/E of 13, no one wanted to touch stocks. Why would they? The expectation was that they would be going down a whole lot more.

Fast forward to 2018.  Now that the P/E is above 34 and the future looks positive, investors can’t seem to get enough of stocks.1 We often allow feelings, which are fleeting, to drive our investment decisions.

Keeping it Cognitive

One of the best ways to keep emotions at bay is to ask reflective questions. An honest assessment can often dampen emotions (less giddy during good times, less fearful during bad times), and empower you to make more thoughtful decisions.

Questioning valuation, investor sentiment, debt etc… can engage the thinking brain (which forces emotions out), and give us a chance to analyze the situation. We can then calculate the actual risk, rather than rely on our emotionally skewed perception of risk.

Knowing Yourself

Our perception of risk is highly fluid – it’s based on mood, media headlines and expectations. As humans, we tend to perceive less risk when times are good and overestimate risk when times are bad.

We are all influenced by emotions, especially with respect to our own money. That’s just part of being human. As your advisor, one of my primary roles is to help you remain disciplined and stick to your plan. Together, we can think things through and ensure that decisions are based on sound judgement and fair valuations, not on how we feel.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

(1) P/E calculations based on Shiller method for S&P 500 Index. The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. All indices are unmanaged and may not be invested into directly.

Information provided by The Emotional Investor, a member of The Behavioral Finance Network. Used with permission.

 

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